18 Jun Getting the facts on finance – Cate Bakos
We sometimes get equity confused with savings by losing sight of the fact that we still have to pay the repayments on the equity loan. That is just one of the finance misunderstanding we discuss with buyers agent Cate Bakos. Also, is P&I at a lower rate better than I/O at a higher rate and how long does a pre-approval last?
Kevin: Joining me once again, Cate Bakos. Cate is a buyer’s agent out of Melbourne. A couple of weeks ago, we talked about the four incorrect assumptions that investors can make. I want to swing this across… Cate is back with me again.
Good morning, Cate.
Cate: Good morning, Kevin.
Kevin: I want to talk about finance now, because there are some finance misunderstandings that I’ve come across as well, and I’d love to get your tilt on these. People get equity confused with savings.
Cate: Yes. This is a significant point, but it’s a really short and sharp point for me to make. There is a big difference. When you have equity available to you for investment purposes or for whatever, it’s really just an easier way than saving the old-fashioned way where you’re putting money aside until you have a substantial enough deposit. You can use that equity as a deposit, but the key thing is that you’re still borrowing it.
So, when people say “I have equity and I have $1 million borrowing capacity, so I have $1 million plus the equity,” the equity needs to form part of that borrowing capacity because they’re borrowing it, they’re not [1:02 inaudible]
Kevin: Yes, very important. What about P&I as opposed to interest-only? Because P&I at a lower rate is sometimes thought to be better than interest-only at a higher rate. What’s your take on that?
Cate: It’s a really topical discussion right now, because obviously, we’ve had a lending clampdown on interest-only that was instigated by APRA some time ago now. But a lot of people are asking me this question, and sometimes when we run the numbers, the P&I option might win. It really does depend on the differential, but there are critical things to bear in mind. You have to factor in your cashflow, obviously, and there are tax deductions to calculate.
Now, I never let tax deductibility be a reason to do something, but it’s definitely a benefit. So, when you’re deciding between interest-only lending or principal and interest, you have to be looking at what else that principal could be doing for you. And if you could offset it against a principal place of residence and achieve your goals that way and it still stacks up for you to do so, then the interest-only option might be the one to go for.
You also have to bear in mind how it impacts your future borrowing capacity, because interest-only will be for a period of time, and then when that fixed term lapses, you’ll then face the prospect of P&I over a shorter period, so your payments will be pushed up as well.
So, it does require sitting down and running the numbers, and if you’re unable to do so, you need to talk to your banker or broker about giving you that information so that you can see it for yourself.
Kevin: Yes, I think it’s an important point that you actually discuss it with your banker or your broker, because everyone’s situation is different, isn’t it, Cate?
Cate: It absolutely is, and future planning comes into it, where you might be with your income. There’s a lot to take into consideration, and it shouldn’t be taken lightly.
Kevin: I want to deal with another one now, Cate. This is a big one, I think, and that is that past approval borrowing as a capacity and the conditions that apply to that approval don’t last long-term and they need to be renewed or reviewed, don’t they?
Cate: Yes. This is one that I couldn’t agree harder on. We’re in a really turbulent time when we consider lending pre-approval and the rate of change in policy and how tough it is out there for a lot of borrowers.
So to assume that your borrowing capacity has lapsed but you’re in a safe place because your situation hasn’t changed is really naïve and really dangerous, because the lenders are changing their policy at quite a rapid rate, and for some people who did service a particular loan comfortably, they can go back to the lender and find that that amount has reduced because the lenders have really clamped down on all kinds of things, including discretionary spending, and they’re paying very careful attention to it.
Kevin: Yes, and this applies very much to anyone who’s, say, bidding at an auction, as an example, or buying in any situation where you don’t have a finance clause. Another instance in here could be – and I’d love to talk to you about this – buying off the plan, because when you buy off the plan, it’s possible that you won’t be settling for anything up to a year, and with finance-only, that approval sitting in place for three months, it should be renewed before you go to settle.
Cate: A really interesting point, Kevin, and it’s a frightening one when you think about it. Off-the-plan purchases can sometimes span for years, and you can look at sunset dates, but there is no pre-approval that will eclipse a sunset date that’s a year or two.
People need to have contingencies for all kinds of things, whether there’s market movement and the price drops, whether lending scrutiny continues and they find themselves unable to settle the purchase themselves. They really need to think carefully about plan B if they’re taking that risky step.
Kevin: Yes, that’s a great topic, and we’ve demystified a few more of those finance misunderstandings for you. Cate Bakos has been my guest. Cate is a buyer’s agent out of Melbourne.
Cate, thanks again for your time.
Cate: Thank you, Kevin.